Serpent on the Rock

by Kurt Eichenwald

  Macejka stressed that the firm had done extensive due diligence, both on the investors’ fund and on VMS itself. “This is one of our best sponsors, with one of their best deals,” Macejka said.

  Near the end of the hour, Creedon circled back to the guarantees again. He had seen guarantees at Hutton that, in reality, applied to the investors’ money only after fees and expenses. Were these guarantees like that, or did they actually protect 100 percent of the cash put in?

  Macejka huffed, clearly offended. “Of course it covers all their money. What kind of people do you think we are?”

  The VMS Mortgage Investment Fund was an out-and-out fraud. What the brokers were told was the finest product ever offered by one of the firm’s strongest sponsors was little more than a desperate attempt to bail out the floundering real estate empire of VMS. The guarantees, which made the deal so attractive to elderly, risk-averse clients, were meaningless.

  The guarantees were only as strong as VMS itself. And VMS was falling apart. Even as the Direct Investment Group was praising the financial skill of VMS, the company was in such a cash bind that it was putting a hold on paying forty-two of its mortgage loans. The same month that the prospectus was filed for the new product, VMS’s executive committee was projecting that the company would have a deficit of more than $140 million for the year. About that time, VMS compiled a huge list of troubled properties, with the total at risk in those investments reaching more than $700 million. One investment called the Buckeye Properties was months away from defaulting. VMS itself had advanced huge sums to Buckeye to keep it afloat. If the property stopped payments, VMS could be wiped out, and the entire real estate empire financed by Darr’s Direct Investment Group would collapse.

  In reality, the mortgage investment fund, sold as one of the safest and most secure deals ever to emerge from Prudential-Bache, was probably the riskiest investment ever produced by the Direct Investment Group. It could survive only with a major boom in the prices of real estate. If that didn’t happen, tens of thousands of the firm’s safety-conscious investors could lose everything.

  But this time, the Direct Investment Group had made a fatal error. Although Prudential-Bache might lie, the stock market does not. And this deal was meant to be listed on a stock exchange. As soon as the shares of the fund started trading, Pru-Bache clients would finally find out how risky these supposedly safe investments were. But trading was not scheduled to start until early 1989. Until then, many of the deceptions from Prudential-Bache would continue unchecked.

  Darr strolled beneath two elegant chandeliers as he headed toward the men’s hairdresser just off the lobby of the Berkeley Hotel in London, England. He pushed open the solid wood door at the front of the salon and walked in. Soon he was seated in one of the three styling chairs, looking out at the picture-window view of Hyde Park. Outside, it was a lovely Tuesday in May 1988. The bright shopping districts of central London and Knightsbridge were chockablock as always with late-afternoon crowds shopping in elegant stores, bustling toward the theaters, or visiting some of the area’s finest museums.

  A stylist came up behind Darr and began snipping his curly white hair. Darr had been busy during his few days in London, where he had traveled with his wife, young daughter, and her nanny. In just a few days, he had toured the city in a hired car and had purchased $1,200 in tickets for the Chelsea Flower Show. His family often ordered room service and ran up huge bills for restaurants. He and his wife stayed in the Pavilion Suite, one of the largest rooms at the hotel, for $1,056 a night, about three times the cost of one of the hotel’s standard rooms. His daughter and her nanny each had her own room. All of them flew to London on the Concorde at a cost of $22,324.66. All told, their trip cost more than $50,000. With the costs picked up by the investors in the energy income and energy growth partnerships, Darr probably thought little about tacking on another $30 to make sure his hair looked nice.

  The trip, held during a week in late May, was the latest and most extravagant of the sales awards sponsored by Graham Resources. It began in London and later moved on to Scotland. Almost every big seller of the Graham partnerships was there. Fred Storaska, who won the trip by selling more of the energy partnerships than all but one of his colleagues during the qualifying period, didn’t come. He was too busy. But Charles Grose, the branch manager so angered by Storaska’s violations of the rules, did get to go, since Storaska’s sales helped qualify him for the trip.

  He joined about 120 other brokers and managers, accompanied by senior executives from the Direct Investment Group and Graham. By that time, any effort to contain costs and protect investors’ savings had been completely abandoned. Darr set the standard. He demanded to stay at the Berkeley, separated from all the other brokers and executives at the prestigious—but far cheaper—London Hilton.

  Paul Proscia insisted on limousine service around the city. Al Dempsey’s wife also hired limousines, at one point using one to go sightseeing at Stonehenge. Dempsey himself spent more than $6,000 on items labeled in the bills as “incidentals.” Pete Theo, the head of Graham’s marketing effort, spent close to $4,000 on tickets for the musical Phantom of the Opera. More than $750 worth of Dom Perignon was consumed in one day. And, on a night in Edinburgh, Scotland, John Graham and other executives spent close to $800 in partnership money to rent kilts for a Highland party.

  Prudential-Bache clients unknowingly lost more than $1 million of their savings as their brokers, led by Darr, spent a week drinking, dancing, and having fun. All as a reward for investing their clients’ capital in partnerships that were secretly falling apart.

  Years later, some of the brokers who went on the trip would reflect that somehow it seemed fitting that this huge, self-indulgent bash would be Darr’s last big waste of partnership money. For as Darr was shuttling about London, senior executives at Prudential-Bache were reviewing a secret, three-volume report about him. Unknown to almost anyone in the Direct Investment Group, some of Darr’s secrets had surfaced months before. The third investigation of his ethics by Prudential-Bache had been launched. But unlike the others, this inquiry had finally hit pay dirt.

  PART THREE

  DISCOVERY

  CHAPTER 14

  LOREN SCHECHTER GLANCED AT his watch before pushing himself back

  from his desk. The time had come for his big performance. In a few minutes on this day in January 1988, Schechter would be playing the bad cop to the good cop portrayal by Frank Giordano, a lawyer in the Direct Investment Group. Schechter was not sure how it would all come off, but he was positive what the results would be: George Watson, whose Watson & Taylor Companies were one of Darr’s favorite general partners, would be stripped of control of his public partnerships sold by the firm.

  Schechter threw on his suit jacket as he headed to the thirty-third floor. Giordano had begun meeting with Watson in a conference room there sometime before. By then, Giordano was supposed to have already laid out the problems they had discovered: From what they saw, Watson had charged too high a price to sell a shopping mall his company owned to one of the public partnerships. Worse, the sale appeared to have bailed Watson out of his personal liability on the property. Even to some of Watson’s own executives, it looked as if he had used money from Prudential-Bache clients for his own benefit.

  On top of that, Watson & Taylor seemed likely to get into deep trouble with federal banking regulators. Lending improprieties at First South had attracted government attention. The regulators had already determined that George Watson and Tracy Taylor secretly controlled more than a quarter of the institution’s publicly traded shares. Watson & Taylor, along with First South, looked like they were about to be slapped with fraud suits by the federal regulators. The prospect of Watson & Taylor’s trouble with the government already worried Darr enough that he had asked Giordano to renegotiate his personal investments in Watson’s private land deals. Originally Darr had personal liability in some of those deals, so if they went bad, he could be on the hook for more money. Bu
t the renegotiated deals absolved Darr of any personal liability and just gave him a share of the investment profits. Usually such a change would cost an investor money, since unloading the liability had enormous value. Watson usually let Darr do it for free. In some instances, Darr did not put cash in the deals as required under the new arrangement. Instead, Watson did it for him.

  But Schechter knew nothing about this intrigue involving Darr’s personal finances. As he stepped off the elevator and headed toward the Direct Investment Group, all he cared about was the federal inquiry and the shopping center deal that benefited Watson. In a way, Schechter was looking forward to confronting Watson. He loved the back-and-forth of legal battles. He tapped on the door of the conference room and stepped inside. Schechter had no idea that the next few minutes would redefine the future of his career and of Prudential-Bache.

  Watson sat opposite Giordano, accompanied by Bruce Manley, who had recently been hired from Franklin Realty to be Watson & Taylor’s national sales manager.

  Watson’s eyes were blazing. Apparently he was putting up a hell of a fight. He did not want to lose control of his partnerships or the fat fees his company received from them. He was in mid-argument as Schechter sauntered up to the table.

  “There was nothing wrong with that property,” Watson said. “It was a good price, a fair price. There is no reason for anyone to be upset about it.”

  Giordano started to make a reply, but Watson interrupted.

  “I told you, Darr himself approved of this deal. How can you say there’s something wrong with it if the head of the department approves it?”

  In fact, Darr had signed off on the deal in December 1986. After Joe Quinn, the head of asset management for the department, rejected the proposal, Watson had taken it directly to Darr. Despite the opinion of his senior staff, Darr sided with Watson.

  Schechter listened to Watson for a few moments. Giordano made some arguments, but Watson was not listening. It looked to Schechter as if he were going to be needed. As he saw his job, he had to get the point across to Watson, in the most obnoxious way possible. Watson started to speak again, but Schechter, standing over the conference table, broke in.

  “This issue is not open for discussion,” he thundered. “This property is being taken out of the partnership, and you are losing the ability to take any more money out of it.”

  Watson looked up at Schechter, his face contorted with controlled rage. “We did everything in this properly, and—”

  “I don’t much care,” Schechter said brusquely. “This is the way we’re going to do it. No discussion. No debate. This is it. You’ve got no choice.”

  Watson sat in his chair, steaming. He locked his fingers together and rested his chin on his hands for an instant. Then he dropped his hands and looked Schechter dead in the eye.

  “This is pretty shabby treatment for someone who has been as nice to one of your senior officers as I have,” he said. “Here I’ve been covering this fellow’s capital investments in our private deals, and now this. Well, I think we all should start being careful about rattling cages.”

  Schechter’s eyebrows raised in astonishment. He had no doubt about what he had just heard or whom Watson was talking about: Darr was using Watson’s money for his personal investing. This could be devastating. Schechter felt sure that nothing like that had been disclosed in the prospectuses for the Watson & Taylor deals. If there was anything to this allegation, then, at best, Darr had received compensation that had not been revealed to investors. It could well have been illegal. If investors found out about it, the lawsuits against Prudential-Bache would be massive.

  Schechter stood up. “This meeting has come to an end,” he said. “I think we have made our position clear. That’s how it stands.”

  He turned and walked out of the room. Watson stood up and stormed down the hallway toward Darr’s office. Darr met with him immediately. Within seconds, the sounds of the two men screaming at each other echoed throughout the thirty-third floor of Prudential-Bache. The noise could even be heard back in the conference room. Manley, Watson’s national sales manager, could not make out the words. But he felt convinced that the fight almost certainly had something to do with the secret that Watson had just spilled to the top legal officer of Prudential-Bache.

  At that moment, Schechter was walking back into his office. He was thinking about speaking to Joel Davidson, another member of the law department. They had to decide quickly which law firm to hire for the investigation into Darr’s relationship with Watson & Taylor.

  As 1988 began, the Dallas law firm of Locke Purnell Rain Harrell had just weathered a few months of chaos. In June, it had become the largest law firm in the city following a merger with a smaller firm. With the combination, Locke Purnell occupied more than six floors in the tall silver tower at First Republicbank Center downtown.

  Locke Purnell had a long history in corporate law and a stellar reputation for its financial and corporate practice. It had handled a range of tax and securities matters for the corporate giants on its client list. But the latest assignment from Prudential-Bache was perhaps the law firm’s most unusual: Schechter wanted Locke Purnell to investigate the financial relationship between a Pru-Bache executive and Watson & Taylor, a prominent real estate company well known to the Dallas lawyers.

  The lawyers running the investigation were Bud Berry and Chris Allison. Berry knew George Watson. The two men traveled in the same social circles and their daughters attended the same school.

  Shortly after being assigned to conduct the investigation, the Locke Purnell lawyers contacted executives at Watson & Taylor, saying they wanted to review all of the company’s documents pertaining to Darr’s investments. Lawyers at Watson & Taylor walked around the company, telling a number of department directors that they should cooperate with the investigation. But apparently no one bothered to tell George Watson about the lawyers poring through the documents in his office, looking for evidence of impropriety.

  Bruce Manley watched all the comings and goings of the Locke Purnell lawyers with interest. From his perspective, by investigationg Darr, they were looking at the right person but weren’t asking all the right questions. Unknown to most of the executives within Watson & Taylor, Manley probably knew more about the allegations surrounding Darr than anyone at the company. When Manley worked for Franklin Realty, he’d developed a close relationship with a number of executives in the partnership department. He had heard all of their stories about Darr hitting up general partners for personal benefits. He knew about Darr’s mortgage with First South. He had been told about Darr taking money from general partners when he worked at Josephthal. He even knew the full story of the Futon Five, the small group of Bache executives who tried to turn in Darr but instead saw their own careers collapse.

  Manley wanted to tell the Locke Purnell investigators everything he had heard, but he was afraid he would lose his job. To report what he knew without facing any trouble himself, Manley figured he had to be sneaky. He decided that he needed to find a go-between, someone who could call Locke Purnell and report the information for him. It only took a second for Manley to know the perfect person to call.

  Manley dialed the number of one of his close friends and sailing buddies. He had no doubt that this man would want to help. After all, his friend had once worked for Darr; he was the one who’d heard from a competitor that Darr took payoffs. But after trying to report the information, he had lost his job as the senior tax shelter executive in the Southwest. To Manley, it seemed a bit of ironic justice that Curtis Henry, one of the original members of the Futon Five, was about to be offered the opportunity to finish what he had helped start more than seven years before.

  The phone rang. “Hello,” Henry drawled.

  “Hey, Curtis, it’s Bruce,” Manley said softly. “We have to talk.”

  A few days later, in the afternoon of January 21, 1988, Curtis Henry sat in his office in San Diego, California, reviewing some notes from his talk with Manle
y. He was with one of his business partners, Charles Humphrey Jr. The two men were extraordinarily close. They had met years before, when Henry still worked for Bache and Humphrey was a lawyer in the tax shelter business. Sometime after Henry left Bache, the two, along with another Futon Five member, David Hayes, had become partners in a franchise of video stores called Major Video.

  Because Humphrey was a lawyer, Henry consulted him about all the information he’d heard from Manley. Manley’s story had left Henry dumbstruck. Although he thought Darr was dirty, Henry had never considered him stupid. He couldn’t believe that Darr would so blatantly intertwine his financial interests with those of his general partners after so narrowly escaping the Futon Five investigation. It struck Henry as almost pathological.

  Humphrey agreed that Manley’s information should be shared with Locke Purnell, but on a few conditions. First, Humphrey should make the call to put a layer between Henry and Locke Purnell. And second, the call should be anonymous. Humphrey wanted to make sure that Henry wasn’t dragged into another confrontation with Darr. It seemed the perfect way to get the information across without risk.

  After a few minutes, Henry finished reviewing the Manley information with Humphrey and looked up from his notes.

  “So that’s it. You ready, Chuck?”

  Humphrey nodded his head. “Yup.”

  “Then let’s do it.”

  Humphrey picked up the telephone and dialed the number for Locke Purnell in Dallas. Henry stood beside him so he could hear every word. It took a while for anyone at Locke Purnell to answer the telephone. It was past 6:00 P.M. in Dallas. The switchboard had shut down for the night.

  Finally Richard Colella, a Locke Purnell lawyer, picked up the phone. Humphrey asked whom he was speaking with, and Colella identified himself.

  “Mr. Colella, I’m not at liberty to give you my name,” Humphrey said. “I am an attorney and a member of the bar. Are you working on the investigation being conducted by Locke Purnell involving Watson & Taylor?”